Column: Pre-tax retirement contributions at risk in tax reform

NEW YORK (Reuters) - If you like the income tax reduction you get for your 401(k) contribution then make sure to max out now, because you may not get the chance in the future.

Members of the U.S. House of Representatives are sworn in on the House floor on the first day of the new session of Congress at the U.S. Capitol in Washington, U.S. January 3, 2017. REUTERS/Jonathan Ernst

Tax reform proposals of past years from both political parties have targeted the break people get for 401(k)s because it is a gigantic source of untaxed money – perhaps more than $580 billion over five years, according to a 2016 Joint Committee on Taxation estimate.

The Tax Policy Center suggests that Congress needs to find $2.4 trillion over 10 years to avoid increasing the deficit with the current tax reform proposal. So the temptation to end the 401(k) tax break could be intense. Currently, 401(k) contributions come from pre-tax earnings, and the government waits until you take the money out in retirement to tax it and the returns it has earned.

If Congress gets rid of this system, saving for retirement would be more like saving in a Roth IRA or Roth 401(k). With a Roth, you do not get any tax benefit when you contribute, but the money grows tax-free in the accounts. These accounts are also not subject to required minimum distributions, which retirees must take from 401(k)s beginning at age 70 1/2.

Roth rules can be a great benefit because people can count on every cent after retirement without worrying about Uncle Sam taxing it. Retirees also are not forced to spend their nest egg, so they can pass it along to heirs with fewer restrictions if they have money left over.

It is not clear, however, how the fine print would shake out, because there is no specific proposal on the table yet from Congress. Nevertheless, retirement saving advocates are bracing for a potential fight over preserving the 401(k) system’s tax breaks as negotiations over tax reform progress. They know Congress will start looking for sources of billions of dollars so it can cut taxes without adding to the nation’s budget deficits, notes Brigen Winters, an attorney with Groom Law Group and lobbyist for 401(k) advocates such as the Plan Sponsor Council of America.

Jack VanDerhei, research director for the Employee Benefit Research Institute, is already studying the potential impact, so he is ready at any time.

The big fear among experts like Winters and VanDerhei is that if people cannot contribute pre-tax money to their 401(k), they will cut back on saving and the nation’s looming retirement savings crisis will worsen. Americans already are saving so little that 52 percent of Americans are on track to struggle in retirement, according to the Center for Retirement Research at Boston College.

The way it works now takes some sting out of saving. For every $1,000 a person in the 25 percent tax bracket socks away, they pay $250 less in taxes, notes the H&R Block Tax Institute. If that money cannot go in pre-tax anymore, they would need to pay tax on all of their income and their take-home pay would diminish.

People do not like to see their take-home pay slip at all, says Aron Szapiro, director of Morningstar Public Policy Research. He calculated that a 30-year-old earning $50,000 and now saving 10 percent of pay, would cut savings to 7.5 percent to maintain the same level of take-home income while working. By retirement, the reduced savings level would lower total contributions to the nest egg to $230,400 from $307,200. And that person would have only about $28,400 for living expenses compared with $30,800, Szapiro found.

Szapiro notes that young workers could ultimately benefit from the Roth treatment if their pay takes a big jump during their careers and they end up with a lot more income when they are retired than when they were young.

But he thinks most people miss an important point: The tax breaks people receive on 401(k) savings in the current system give them the financial leeway to save more early in life.

“If you take that away, people are going to say: why should I bother to contribute?’” says Szapiro. “It will be hard to get people to act, and that would be very bad for people in retirement.”